Your Money: Soft landing or soft recession?

Stronger growth overseas and a much weaker dollar have boosted US exports, ensuring manufacturing expansion.

By AARON LEITNER

October 11, 2007 06:57

dollar graf 88 224.
(photo credit: Bloomberg chart)

The risks of recession in the US have declined, economists expect a "soft landing." The Fed's 50-basis point rate cut this month has caused economists to view this move as a shift in policy; supporting economic activity, rather then focusing on inflation. It also has been viewed as an indication that the Fed is concerned about the threat of a recession.
September's economic data releases were mixed. The housing market continued to slump, manufacturing indexes declined, retail sales growth was negligible and consumer confidence declined to a two-year low as home sales were reported to be at the lowest in seven years. Initially, a rise in unemployment was reported, but the revised data showed that US employment accelerated in September and revised figures for August showed an unexpected gain, easing concern the economy was headed toward recession. With no disaster emerging, the expectations of another rate cut have diminished significantly.
The rate cut contributed to the dollar's historic low to the euro since its inception in 1999 - $1.42 (though it has regained some strength afterwards). The dollar had its biggest monthly drop against the euro in almost four years. Continued moderate depreciation can be expected, although the analysts expect that the dollar will rebound to under $1.40 (to the euro) by year-end. The US currency in September depreciated against all 16 major world currencies.
Stronger growth overseas and a much weaker dollar have boosted US exports, ensuring manufacturing expansion. According to estimates by Goldman Sachs, exports of goods grew more than twice as fast as imports in the first half of 2007, and the trade gap continued to shrink as the US multi-nationals reported a substantial increases in exports. Though the continued housing slump and tighter credit markets threaten consumer spending, stronger exports can be expected to contribute to growth. Currently signs of inflation are benign.
Downside risks have increased, predominantly in terms of consumption spending in the face of increased economic uncertainty and falling house prices in many states. Economists predict that the labor market will soften in coming months, further restraining growth in retail sales.
Consumer spending is unlikely to collapse, but given its share of GDP (about 70 percent), even a slight change is bound to have an impact. It is now expected, that the US economy will grow at 1.8%-2% in 2007, lower then previous estimates, albeit the expectations are that we are likely to see a benign slowdown instead of full-blown recession.
On the other hand, the slow growth environment is likely to linger. Rating agency Standard & Poor's warned that the subprime crisis will not peak until 2009, and the International Monetary Fund has slashed its 2008 growth forecast for the US from 2.5% to 1.8%.
So far, there is no cause for excessive concern for the Eurozone economy as yet, since core data has generally confirmed a solid growth picture. However, a series of disappointing surveys from the business and consumer sectors, such as the weaker than expected German September IFO survey, reflect the fact that the financial market turmoil is filtering through to the real economy, and that the first signs of diminished growth are becoming visible. These signs are still limited, though, as data shows rising French consumer spending, a solid Eurozone industrial production trend accompanied with declining unemployment levels. In spite of larger then expected declines in unemployment, September's German consumer confidence index decreased; the drop of sentiment resulting from negative economic headlines in the press, soaring oil prices and concerns over the European housing sector.
Exports are on a positive trend, supported by strong global economy, but it is only a matter of time before an appreciating euro becomes more problematic, especially considering that some of the Eurozone key trading partners' (namely the US and the UK) economies are slowing down.
Rising bank borrowing costs and the interest rate levels in six years are having an averse effect on the business sector. With inflation still running close to the ECB's 2% ceiling (after 12 consecutive months below that level) and with wage inflation remaining well contained, one would tend to conclude that inflation risks remain limited in the Eurozone. Yet, the ECB message remains hawkish, with high oil prices and persistent inflation pressures from food prices keeping the ECB alert. It is likely that the ECB will leave its monetary policy unchanged for the moment, with an option of rate hikes, if necessary.
GDP growth is still strong, at an expected 2.2%-2.8% growth rate this year and 1.8%-2.5% in 2008. As regards to individual countries growth, the highest rates are projected in Ireland and the lowest in Italy. Nonetheless, there are indications of a growth slowdown trend in the Eurozone economy resulting from financial market turbulence.
It will probably take some time for the Japanese economy to regain its growth pace, but it looks like the overall situation is improving. Inflation pressures have replaced deflation (the economy's primary risk), wages and incomes have begun to rise, and industrial production should continue to be supported by robust international demand for vehicles and electronics.
investment bank Goldman Sachs, in its updated report, forecasted that the Japanese economy will grow 2.0% this year and 2.5% in 2008.
China continues to grow at a rapid pace, and so are other developing Asian countries. For the most part, this growth is not dependent on exports to the US so the fears that America's deceleration will slow down China - and through it the rest of the global economy - are probably exaggerated. Moreover, China, as well as other economies in the region, is benefiting from rapidly growing domestic demand and a strong pick up in investment.
The markets are used to looking at the US as the main driver of world growth. This was true in the 90s, when America contributed 25%-35% of the hi-tech driven increase in global GDP, but it isn't so anymore.
The US contribution to world GDP has been subsiding for several years, and in the 2004-2006 economic boom it provided about 15% of total growth. The US is still the world's largest single economy, but now the players that dominate global growth are China and other emerging Asian countries. It is also important to note that, contrary to popular perception, exports to the US comprise a relatively small percentage of the growth-drivers GDP. And while high as ever energy prices are some economies' curse, the oil exporters, such as Russia, Mexico and OPEC, continue to profit from the situation. This situation is expected to help the world economy to withstand the ongoing US economic slowdown and continue to register above-trend growth of about 4.2% (IMF's projection).
Standard & Poor's says it expects the world economy to grow 3.6% in 2007 and 3.5% in 2008 in spite of the subprime crisis, which it says will not peak until early 2009.
International investment bank Goldman Sachs has updated its growth forecasts for the world countries and regions. According to the revised estimations, developed economies will grow at 2.6% rate this year and at 2.2% in 2008, while emerging markets will grow 8.4% in 2007 and 7.7% next year. The world as a whole, says the bank, will register growth of 4.7% this year and 4.2% in 2008. The bank's chief economist, Jim O'Neill said, "the key question, which will take time to answer, is the extent to which the credit crunch will affect the real economy."
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The author is global investment strategist at Tandem Capital.
Yulia Vaiman/Macro Research Analyst at Tandem Capital contributed to this report.

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